Gambling With Your Retirement
By Paul Krugman
The New York Times

February 4th, 2005

A few weeks ago I tried to explain the logic of Bush-style Social Security privatization: it is, in effect, as if your financial adviser told you that you wouldn’t have enough money when you retire - but you shouldn’t save more. Instead, you should borrow a lot of money, buy stocks and hope for capital gains.

Before President Bush’s big speech, a background briefing by a “senior administration official” made it clear that the plan calls for exactly the “borrow, speculate and hope” strategy I described - not just for the system as a whole, but for each individual.

Here’s the money quote: “In return for the opportunity to get the benefits from the personal account, the person forgoes a certain amount of benefits from the traditional system. Now, the way that election is structured, the person comes out ahead if their personal account exceeds a 3 percent rate of return” - after inflation - “which is the rate of return that the trust fund bonds receive. So, basically, the net effect on an individual’s benefits would be zero if his personal account earned a 3 percent rate of return.”

Translation: If you put part of your payroll taxes into a personal account, your future benefits will be reduced by an amount equivalent to the amount you would have had to repay if you had borrowed the money at a real interest rate of 3 percent.

Peter Orszag of the Brookings Institution got it exactly right: “It’s not a nest egg. It’s a loan.”

For years, privatizers - including Mr. Bush - have claimed that people would do better with private accounts than with traditional Social Security even if they played it safe and invested in U.S. government bonds (which yield 3 percent after inflation).

But the official at the briefing made it clear that his boss was fibbing: if you invested your private account in government bonds, you would face benefit cuts equal in value to your investment, so you would be no better off than under the current system.

The only way to get ahead would be to invest in risky assets like stocks, and hope for higher yields. But if the investment went wrong and you earned less than 3 percent after inflation, your benefit cuts would leave you poorer than if you had never opened that private account.

So people are expected to take a loan from the government and use it to buy stocks, and if that turns out to have been a mistake - well, too bad.

Experts usually tell people to plan for their retirement by investing in a mix of stocks and bonds. They disapprove strongly of speculation on margin: borrowing to buy stocks. Yet Mr. Bush wants tens of millions of Americans to do exactly that.

Meanwhile, what does any of this have to do with the ostensible purpose of the whole thing: saving Social Security?

Here’s the senior official again: “In a long-term sense, the personal accounts would have a net neutral effect on the fiscal situation of Social Security.” The government would have to borrow huge sums up front to create the personal accounts - $4.5 trillion in the first two decades - but it would supposedly make up for all that borrowing with offsetting cuts in account holders’ benefits many decades later.

Color me skeptical: will retirees with private accounts that performed badly really be forced to repay their loans in full? Even if they are, private accounts will at best have a “net neutral effect” - that is, they will do nothing to improve Social Security’s finances. Mr. Bush says the system faces a crisis; what does he propose to do about it?

The answer, presumably, is that his plan will also involve major benefit cuts over and above those associated with private accounts. And it’s true that you can improve Social Security’s finances with privatization, as long as you also slash benefits - just as you can kill a flock of sheep with witchcraft, provided you also feed them arsenic. (Thanks, M. Voltaire.)

Do you believe that we should replace America’s most successful government program with a system in which workers engage in speculation that no financial adviser would recommend? Do you believe that we should do this even though it will do nothing to improve the program’s finances? If so, George Bush has a deal for you.

(In accordance with Title 17 U.S.C. Section 107, this material is distributed without profit to those who have expressed a prior interest in receiving the included information for research and educational purposes.)

Don’t Use FDR To Undermine Social Security
By James Roosevelt Jr.
The Boston Globe

January 31st, 2005

In his inaugural address, President George W. Bush invoked the name of my grandfather, President Franklin D. Roosevelt, as part of his campaign to privatize Social Security. Similarly, a political organization supporting that drastic change recently ran a television commercial using a newsreel clip showing President Roosevelt signing the Social Security Act into law. The implication that FDR would support privatization of America’s greatest national program is an attempt to deceive the American people and an outrage.

President Roosevelt founded Social Security for very basic but important reasons. He believed that the only enemy that could ever defeat the United States was fear itself. He and my grandmother, Eleanor, looked at America and found fear of want — particularly after retirement or loss of a parent. Today, thanks in large part to Social Security, the number of older Americans below the poverty line has dropped from almost 50 percent to only 8 percent.

FDR believed that Social Security should be simple, guaranteed, fair, earned, and available to all Americans. President Roosevelt was adamant that Social Security was an insurance program to provide basic needs in retirement.

As a former Wall Street lawyer, my grandfather fully supported the opportunity of every American to have fair investment opportunities. But Social Security was — and is — something different. It was — and is — the guaranteed basis of a secure retirement. The risk is that future retired Americans will lose that assurance if the guaranteed benefit is eliminated. Drastic changes that divert the payroll tax to privatization will almost certainly eliminate that guaranteed benefit by crippling the ability to pay benefits, imposing trillions of dollars of new costs on the government and creating massive federal debt. Privatization threatens to bring about the collapse of the entire Social Security system.

FDR was realistic about the need to adapt Social Security as the workforce evolved. In my office I have his original handwritten note to my father outlining the principles I’ve just discussed. By the time the program was enacted in 1935, the details were quite different. But the principles remained the same.

Throughout the six successful decades of Social Security, it has been adjusted in both benefits and revenues. But it has continued to observe FDR’s principles of a secure, guaranteed retirement income provided by an insurance system that all workers pay for. Then, as now, the key to taking the fear out of the Social Security debate is speaking truthfully. Instead, the proponents of privatization have not only misused the name and image of my grandfather, they have mischaracterized undisputed facts to create a phony impetus for abandonment of the program.

Those who are seeking immediate, drastic change should recognize that even the Social Security trustees appointed by the president agree that Social Security with no changes could pay full benefits until 2042, even under pessimistic assumptions about economic growth. They should recognize that the Congressional Budget Office says that Social Security with no changes could pay full benefits until 2052. They should recognize that even then benefits would be cut only about 25 percent if there were no changes, not nearly as drastically as most private account proposals would cut them. The lies and half-truths from the proponents of privatization must stop.

Most of all, the creation of fear by the unjustified use of words like “crisis” and “bankruptcy” is destructive of a reasonable debate about what adjustments to Social Security will ensure the payment of full benefits throughout the 21st century. Every honest person knows that there is no crisis, there is no threat of bankruptcy, and that what is needed are adjustments, not drastic measures like privatization. Just as bad is the use of terms like “worthless IOUs” to describe US Treasury bonds held by the trust fund. These are scare tactics designed to create fear.

These attempts to divide grandparents, parents, and children are an attack on the most successful program this country has ever had. Social Security unites the interests of my parents’ generation, my contemporaries, and my children’s generation. It can be strengthened with incremental changes. To achieve that, the Congress and the White House must work together — without ideological agendas. FDR’s goal of freedom from fear can be preserved by truthful, reasonable negotiation that is free of false implications and misrepresentation.

James Roosevelt Jr. is a lawyer and former associate commissioner of Social Security.

(In accordance with Title 17 U.S.C. Section 107, this material is distributed without profit to those who have expressed a prior interest in receiving the included information for research and educational purposes.)

The Free Lunch Bunch
By Paul Krugman
The New York Times

January 21st, 2005

Did they believe they would be welcomed as liberators? Administration plans to privatize Social Security have clearly run into unexpected opposition. Even Republicans are balking; Representative Bill Thomas says that the initial Bush plan will soon be a “dead horse.”
That may be overstating it, but for privatizers the worst is yet to come. If people are rightly skeptical about claims that Social Security faces an imminent crisis, just wait until they start looking closely at the supposed solution.

President Bush is like a financial adviser who tells you that at the rate you’re going, you won’t be able to afford retirement - but that you shouldn’t do anything mundane like trying to save more. Instead, you should take out a huge loan, put the money in a mutual fund run by his friends (with management fees to be determined later) and place your faith in capital gains.

That, once you cut through all the fine phrases about an “ownership society,” is how the Bush privatization plan works. Payroll taxes would be diverted into private accounts, forcing the government to borrow to replace the lost revenue. The government would make up for this borrowing by reducing future benefits; yet workers would supposedly end up better off, in spite of reduced benefits, through the returns on their accounts.

The whole scheme ignores the most basic principle of economics: there is no free lunch.

There are several ways to explain why this particular lunch isn’t free, but the clearest comes from Michael Kinsley, editorial and opinion editor of The Los Angeles Times. He points out that the math of Bush-style privatization works only if you assume both that stocks are a much better investment than government bonds and that somebody out there in the private sector will nonetheless sell those private accounts lots of stocks while buying lots of government bonds.

So privatizers are in effect asserting that politicians are smart - they know that stocks are a much better investment than bonds - while private investors are stupid, and will swap their valuable stocks for much less valuable government bonds. Isn’t such an assertion very peculiar coming from people who claim to trust markets?

When I ask privatizers that question, I get two responses.

One is that the diversion of revenue into private accounts doesn’t have to lead to government borrowing, that the money can come from, um, someplace else. Of course, many schemes look good if you assume that they will be subsidized with large sums shipped in from an undisclosed location.

Alternatively, they point out that stocks on average were a very good investment over the last several decades. But remember the disclaimer that mutual funds are obliged to include in their ads: “past performance is no guarantee of future results.”

Fifty years ago most people, remembering 1929, were afraid of the stock market. As a result, those who did buy stocks got to buy them cheap: on average, the value of a company’s stock was only about 13 times that company’s profits. Because stocks were cheap, they yielded high returns in dividends and capital gains.

But high returns always get competed away, once people know about them: stocks are no longer cheap. Today, the value of a typical company’s stock is more than 20 times its profits. The more you pay for an asset, the lower the rate of return you can expect to earn. That’s why even Jeremy Siegel, whose “Stocks for the Long Run” is often cited by those who favor stocks over bonds, has conceded that “returns on stocks over bonds won’t be as large as in the past.”

But a very high return on stocks over bonds is essential in privatization schemes; otherwise private accounts created with borrowed money won’t earn enough to compensate for their risks. And if we take into account realistic estimates of the fees that mutual funds will charge - remember, in Britain those fees reduce workers’ nest eggs by 20 to 30 percent - privatization turns into a lose-lose proposition.

Sometimes I do find myself puzzled: why don’t privatizers understand that their schemes rest on the peculiar belief that there is a giant free lunch there for the taking? But then I remember what Upton Sinclair wrote: “It is difficult to get a man to understand something when his salary depends on his not understanding it.”

(In accordance with Title 17 U.S.C. Section 107, this material is distributed without profit to those who have expressed a prior interest in receiving the included information for research and educational purposes.)

E-mail: krugman@nytimes.com

A Bloody Mess
By Norma Cohen
January 11th, 2005

The American Prospect

From the February 2005 issue: How has Britain’s privatization scheme worked out? Well, today, they’re looking enviably upon Social Security.

A conservative government sweeps to power for a second term. It views its victory as a mandate to slash the role of the state. In its ®!=rst term, this policy objective was met by cutting taxes for the wealthy. Its top priority for its second term is tackling what it views as an enduring vestige of socialism: its system of social insurance for the elderly. Declaring the current program unaffordable in 50 years’ time, the administration proposes the privatization of a portion of old-age benefits. In exchange for giving up some future benefits, workers would get a tax rebate to put into an investment account to save for their own retirement.
George W. Bush’s America in 2005? Think again. The year was 1984, the nation was Britain, the government was that of Margaret Thatcher — and the results have been a disaster that America is about to emulate.

For all the fanfare that surrounds the Bush administration’s efforts to present a bold new idea on pension reform, the truth is that it is not new at all. In fact, the proposal looks suspiciously like the plan set in train during Thatcher’s fitst term in 1979 and which has since led Britain to the brink of a crisis. Since then, the nation’s basic pension, which is paid for out of tax receipts, has shrunk dramatically. The United Kingdom has the stingiest state pension program of any G8 nation, and there is growing consensus — even among British conservatives — that reform is needed. And ironically enough, considering that America is on the verge of copying Britain’s mistake, most experts seek reform in the direction of a more generous, and simpler, basic state pension — one similar in design, in other words, to America’s Social Security program.

David Willetts, the Conservative MP who is the opposition spokesman on pensions (and whose intellectual agility has earned him the sobriquet “Two Brains”), is one admirer of the U.S. system. “I like the way they distinguish between Social Security and means-tested welfare,” he says. “They have higher Social Security benefits to keep elderly people off welfare.” And last year, in a startling reversal of its decades-old policy, the Confederation of British Industry, the United Kingdom’s premier business group and the functional equivalent of the U.S. Chamber of Commerce, called for a more generous state retirement benefit, saying — remember, this is the nation’s leading business lobby talking — that it would even support raising taxes to help pay for it. (It also called for raising the retirement age.)

Britain’s experiment with substituting private savings accounts for a portion of state benefits has been a failure. A shorthand explanation for what has gone wrong is that the costs and risks of running private investment accounts outweigh the value of the returns they are likely to earn. On average, fees and charges can reduce pension lump sums by up to 30 percent on retirement. The nation’s savings industry, which sells those private accounts, has already acknowledged this. Which brings us to irony No. 2: Just as the United States prepares to funnel untold billions to its private sector for the management of private accounts, back in 2002, many U.K. insurance companies, mindful of tough new rules against giving bad advice, began to write to their customers urging them to consider abandoning their private savings and returning to the state pension system — something hundreds of thousands of Britons have done already.

And this is the system that the United States is seeking to emulate?

* * *

How Britain’s retirement system got to where it is today is a twisted tale that combines political ideology with fiscal expediency.

Britain has had pensions since medieval times; offering them to monks and abbesses was Henry VIII’s simple formula for dissolving Catholic monasteries without a revolt by their occupants. They were given more widespread use in the late 19th century by some of the more enlightened entrepreneurs. But it was the aftermath of World War II that saw the widespread inclusion of pension benefits into workers’ benefits packages. Britain’s nationalization of its heavy industries such as coal, steel, and railroads made pensions as much an element of social policy as of employment policy. At the time, Britain was suffering a manpower shortage so acute that, for the first time, it encouraged citizens of its former West Indian colonies to settle there. For employers in certain industries such as retailing and banking, dependent on large numbers of relatively low-wage workers in a labor-restricted economy, pensions were a low-cost insurance policy against high staff turnover that could drive up wage bills. The system was, to be sure, complex and not without its inequities. But it was not in crisis.

Thatcher (now a baroness) came to power in May 1979 at a time when much of Britain was ready to hear her message. The now-infamous poster of workers on the dole queue, headlined “Labour Isn’t Working,” coupled with national disgust over a series of strikes during the 1979 “Winter of Discontent” that left bodies stacked at morgues in Liverpool and trash piled high in London’s Trafalgar Square, made Britons eager for change.

Thatcher’s vision was the dismantling of much of what Britain’s Conservative Party calls “the nanny state.” Individual choice and individual opportunity were to be the hallmarks of this dismantling. No longer would the state seek to shield people from the force of the markets; people would have to learn to stand on their own two feet. Britain was to be a nation of home-owning, share-owning entrepreneurs who did not want the state snooping into their business or asking more of them than good citizenship.

From the start, the new Tory government set out to make tax cutting the centerpiece of its fiscal policies. However, it was clear that this could not be accomplished without benefit cuts. As former Chancellor of the Exchequer Nigel Lawson notes in his memoirs, the single most important cut was directed at retirement benefits. So the Tories’ very first budget, passed by Parliament in 1979, included a fateful change in the formula for basic state pensions. For years before that, state pensions had risen in line with wages; but the 1979 budget decreed that in the future, they would rise in line with inflation. This is one key change that the Bush administration is contemplating today for Social Security.

In Britain, by most accounts, the change caused little political fanfare at the time. Ros Altmann, a Harvard-trained specialist in pension economics and a governor at the London School of Economics, says that neither the voting public nor most politicians understood the true implications of altering the link to wages. But those who pushed for the change knew what they were doing: They were slowing the rate of growth in pension increases, because in the United Kingdom, wages have historically risen by 1.5 percentage points to 2 percentage points ahead of inflation each year. (Wages rise ahead of inflation in America as well.) “Two percent doesn’t sound like much,” Altmann notes. “But with the effects of compound interest, that amounts to nearly a 50-percent reduction in the value of benefits over 30 to 40 years.” As a result, the basic state pension in the United Kingdom — the equivalent of U.S. Social Security — is today lower than that in all but four other European countries: Portugal, Greece, Belgium, and Ireland. It is also substantially below that of its U.S. counterpart.

The American observer may ®!=nd it odd that Britain’s voting public was prepared to put up with so low a basic state pension. Why did voters never demand more generous old-age benefits? The answer lies in the fact that the United Kingdom has one of the most generous employer-backed pension systems in Europe. Aggregate assets in U.K. pension funds far outstrip the value of similar funds on the continent. Indeed, in a report issued last October, the Pensions Commission acknowledged this very point. “The UK pension system appeared in the past to work well because one of the least generous systems in the developed world was complemented by the most developed system of voluntary private funded pensions,” the commission wrote. “This rosy picture always hid multiple inadequacies relating to specific groups of people, but on average the system worked.”

Thus, with most Britons assured that their private pensions would protect them, the Tories faced little opposition as they kept at reducing state pensions. The Labour Party, then in opposition, was relatively acquiescent, in part because just a few years earlier, a bipartisan group had agreed on a new legislative centerpiece that was designed to ensure that old-age pensions retained their purchasing power. This legislation established a new and more generous second tier of the basic state pension, which was to be known as SERPS (State Earnings-Related Pension Scheme) and which promised to deliver every worker an additional pension, over and above the basic-level pension and equal to a percentage of the average of his or her best 25 years of wages.

* * *

That additional pension was known as the Guaranteed Minimum Pension (GMP) because, unlike the basic state pension, it set a floor under the smallest benefit a worker could expect in retirement. But it contained an interesting wrinkle: Employers who provided their own schemes for their workers could be allowed a reduction of roughly 60 percent of their payroll taxes if they guaranteed to provide a pension at least as good as the GMP.

Thus was established the principle of “contracting out,” the British term for allowing citizens to divert money from state schemes and to invest instead in private plans — the term of art, in other words, for privatization. The practice was finally put into place in force with a piece of legislation that passed in 1986.

The narrative of how this came to pass will sound familiar to those who have been following the current debate in America. At the start of 1984, then-Chancellor Nigel Lawson (now Sir Nigel; his daughter Nigella has more recently won great culinary fame on American television) had begun to express his alarm at projections for the cost of SERPS over the next 50 years. A colleague in the cabinet, Social Security Secretary Norman Fowler (also now a “Sir,” albeit one lacking a daughter famous in the States), advocated abolishing it altogether. In his memoirs, Lawson describes SERPS as “a doomsday machine” and calls its provisions “irresponsible generosity.” Both men were strong advocates of personal pensions. However, what Lawson does not say is that while the SERPS expenditure was likely to peak in the year 2030 (projections for that year appeared in all discussions about the need to curtail it), it was projected to fall off after that. But — here’s another wrinkle that should sound familiar to American ears — by focusing on projections for 2030, the sense of impending crisis prevailed in the media.

And so, in 1985, the Conservatives pushed through what would become the landmark legislation of social-security privatization. The new law curtailed some SERPS benefits; allowed employees the choice of either joining SERPS or setting up a personal pension scheme; and, crucially, allowed those choosing a personal pension to contract out of SERPS altogether. It was these last two elements, when combined, that led to one of the greatest financial scandals in recent memory and that, together, have undermined confidence in long-term savings in Britain.

The new rules on personal pensions and contracting out did not take effect until 1988. But in the months leading up to their launch, the government spent substantial sums on advertising aimed at encouraging Britons to take them up. The Thatcherite government was so eager to pursue its ideological agenda that it spent taxpayers’ money on it; the 1985 act had included a payment into the fund giving an additional 2-percent tax rebate to those taking out a new personal pension between 1988 and 1993.

When contracting out began, predictions from the Government Actuary’s Department forecast that no more than 500,000 people would take up personal pensions. A former official told the Financial Times at the time, “We all told the secretary of state that personal pensions were really only good for the very young or for very high earners.” But in the first five years, the number of private pensions sold would turn out to be 10 times those two segments of the population. The legislation, and the accompanying public-relations blitz, worked: The “take-up,” as the British call it, of personal pensions was successful beyond the ministers’ wildest dreams and was hailed as one of the triumphs of the Tory government. By the end of the 1988-89 tax year — the first year in which they were available — more than 1 million private pensions had been sold, twice the government projection. By the end of the following tax year they totaled 3.9 million, rising to 4.3 million at the end of the 1991 tax year.

It wasn’t until a July 1992 gathering of ministers and civil servants at Chevening, the chancellor of the exchequer’s country residence, that the government got its first official warning that all was not well. On the opening day of a strategy session called by then-Social Security Secretary Peter Lilley, ministers were alerted to the costs now associated with persuading people to opt out of occupational and state pension schemes into personal pension plans. The warning came from David Clark, then deputy secretary for pensions, in a paper to the assembled group. A minister recalled to me, “The paper said that, in some sense, personal pensions have been a tremendous success, but there are a few time bombs ticking away there.”

A report written two years earlier by the National Audit Office confirmed what Clark had told the disbelieving ministers. The government had sent out 9 billion in rebates from 1988 to 1993 to people who had agreed to contract out; but at the same time, the massive shift to private pensions was going to cut SERPS costs by only 3.1 billion. In other words, the government was spending much more than it was saving by bribing people to leave SERPS. What had once been a 1.6-billion surplus in the National Insurance Fund vanished completely. Worst of all, many workers left good occupational plans and faced being worse off, not better off, in retirement by depending on the privatized schemes.

Finally, Britain’s financial services regulator, the Securities and Investment Board, reacted. Over the objections of the insurance industry, it undertook random samples of paperwork from personal pension clients of most large providers and discovered that a staggering percentage of pensions had been sold to those who would be worse off in retirement as a result. The public outcry over the “mis-selling” scandal forced the government to act. It established a review panel and ordered that all those who had been made worse off by taking out a personal pension be compensated by the seller. Over the next eight years, roughly 1.7 million people sought and received compensation that ultimately cost the insurance industry 12 billion. In addition, hundreds of millions were paid out in fines and penalties. It was the biggest financial scandal in the United Kingdom to date.

In retrospect, it is no surprise that personal pensions became controversial; the insurance industry, which would benefit most from their creation, was also the most influential in crafting their design. For advice, Fowler relied heavily on a small group that included the highly influential insurance executive Sir Mark Weinberg, who had launched three insurance companies. According to Fowler’s former aides, no one influenced Fowler more than Weinberg. “In the main, Weinberg was the only person in the industry who Fowler had direct contact with,” one former staffer says.

* * *

Today, another financial scandal looms, and this one could be bigger. It involves the United Kingdom’s occupational schemes, long the backbone of retirement provision (they are the British equivalent of traditional U.S. pension plans).

The drop in real interest rates and the accompanying disappearance in high returns on equities have left most British occupational pension schemes in deficit. Employers sponsoring some 70 percent of all denied-benefit plans — in which the retirement pay is a percentage of the final salary — have shut their doors to new members. Instead, as with American 401(k) plans, employers are offering defined-contribution plans in which company contributions, per worker, are very much lower than those of the schemes they replace. They’re unlikely to ever deliver anything like the old-style retirement benefits. What has made this abandonment particularly acute is that the United Kingdom was so confident of the strength of its occupational plans that Tory and Labour governments alike insisted that no insurance scheme would be necessary.

But the crisis within the occupational pension system has laid bare just how inadequate Britain’s public pension schemes have been. Now, some 65,000 British workers have lost all or part of their pensions as a wave of insolvent employers are discovered to have left their pension schemes severely underfunded. Some do not even have the cash to pay the GMPs that were promised in exchange for tax rebates. A 1995 attempt at reform fizzled. Those who have lost out have discovered that they have nothing to fall back on except the basic state pension, which is now so miserly because of changes put in place during the first year of the Thatcher reign that those relying solely upon it for their retirement income are defined as destitute. And that GMP, which was meant to supplement the basic state pension? “The Guaranteed Minimum Pension turned out to be neither guaranteed nor a minimum,” says Ros Altmann of the London School of Economics. “These people would have been better off keeping their money under the mattress.”

This, then, is the situation in Britain today:

* According to the Department for Work and Pensions, in 2004 alone, 500,000 people abandoned private pensions and moved back into the state system. Government actuaries expect another 250,000 to contract back in this year.

* In 2004, the Association of British Insurers, the trade association representing the companies that sell the private accounts, made a collective decision not to risk any more allegations of mis-selling. It urged all of its member firms to warn those who had taken tax rebates to open private accounts that they might have made a bad choice. The advice was particularly aimed at older workers with fewer years until retirement.

* Many insurance companies — the sellers of the private accounts — have been writing their customers urging them to contract back in to the state system.

* And, of course, even the U.K. version of the U.S. Chamber of Commerce has endorsed the idea of raising taxes to increase benefit levels.

* * *

Pension policy threatens to become a key issue in the British elections in May. To be fair, the United Kingdom is hardly alone in facing a pension crisis. With sharp increases in life expectancy among the elderly and plunging fertility rates, every nation in the world will face similar challenges. Moreover, the demographic patterns are similar even in less-developed nations; Mexico, for instance, is forecast to have old-age life expectancy similar to that of the United States in a few decades’ time.

But whatever the solution to that challenge, there is little disagreement within the United Kingdom that the path chosen by successive governments over the past 25 years is not the right one. The Pensions Commission recently completed the most comprehensive review ever of the U.K. system and concluded that there are only four possible solutions for the difficulties ahead: cutting state retirement benefits, increasing taxes, increasing savings, or delaying retirement. While noting that there is no political support for the first choice, the commission concluded that each of the three other choices, on its own, is too painful. Only some combination of them is likely to help Britain’s elderly obtain retirement with dignity. Adair Turner, chairman of the commission, a vice chairman of Merrill Lynch in London, and the former director general of the United Kingdom’s biggest business lobbying group, says, “There are no other choices.”

And so, at the exact moment that America contemplates replicating this disaster, many in Britain — some conservatives included — are looking more and more kindly on American Social Security as a model for reform. The National Association of Pension Funds, a group of employers who sponsor the nation’s largest schemes, is urging government not to expect the private sector to shoulder the burden of keeping the nation’s elderly from poverty. Chief executive Christine Farnish notes that it’s “actually cheaper for the state to carry the risk,” adding that in looking for a system that offers the best combination of modest guaranteed retirement benefits delivered at low cost, the U.S. Social Security program seems the best model. “It doesn’t have to make a profit, and it delivers efficiencies of scale that most companies would die for,” she says.

And that is how the British eye, wearied after beholding decades of privatization “reform,” views the American system, which has served the United States so remarkably well for seven decades but which supposedly is now in dire crisis and must be overhauled by the time the forsythia bloom. It’s a point of view Americans would do well to take in.

Norma Cohen is senior corporate reporter at the Financial Times and is currently responsible for coverage of pension issues. This article was made possible by a grant from the Center for American Progress. Members of the press interested in talking with Cohen should contact Alison Leff at pr@prospect.org

(In accordance with Title 17 U.S.C. Section 107, this material is distributed without profit to those who have expressed a prior interest in receiving the included information for research and educational purposes.)

Confusions About Social Security
By Paul Krugman
The Economists’ Voice

Volume 2 Issue 1 2005

Summary: There is a lot of confusion in the debate over Social Security privatization, much of it deliberate. This essay discusses the meaning of the trust fund, which privatizers declare either real or fictional at their convenience; the likely rate of return on private accounts, which has been greatly overstated; and the (ir)relevance of putative reductions in far future liabilities.
Introduction

Since the Bush administration has put Social Security privatization at the top of the agenda, I’ll be writing a lot about the subject in my New York Times column over the next few months. But it’s hard to do the subject justice in a series of 700-word snippets. So I thought it might be helpful to lay out the situation as I see it in an integrated piece.

There are three main points of confusion in the Social Security debate (confusion that is deliberately created, for the most part, but never mind that for now). These are:

* The meaning of the trust fund: in order to create a sense of crisis, proponents of privatization consider the trust fund either real or fictional, depending on what is convenient

* The rate of return that can be expected on private accounts: privatizers claim that there is a huge free lunch from the creation of these accounts, a free lunch that is based on very dubious claims about future stock returns

* How to think about implicit liabilities in the far future: privatizers brush aside the huge negative fiscal consequences of their plans in the short run, claiming that reductions in promised payments many decades in the future are an adequate offset

Without further ado, let me address each confusion in turn.

The Trust Fund

Social Security is a government program supported by a dedicated tax, like highway maintenance. Now you can say that assigning a particular tax to a particular program is merely a fiction, but in fact such assignments have both legal and political force. If Ronald Reagan had said, back in the 1980s, “Let’s increase a regressive tax that falls mainly on the working class, while cutting taxes that fall mainly on much richer people,” he would have faced a political firestorm. But because the increase in the regressive payroll tax was recommended by the Greenspan Commission to support Social Security, it was politically in a different box - you might even call it a lockbox - from Reagan’s tax cuts.

The purpose of that tax increase was to maintain the dedicated tax system into the future, by having Social Security’s assigned tax take in more money than the system paid out while the baby boomers were still working, then use the trust fund built up by those surpluses to pay future bills. Viewed in its own terms, that strategy was highly successful.

The date at which the trust fund will run out, according to Social Security Administration projections, has receded steadily into the future: 10 years ago it was 2029, now it’s 2042. As Kevin Drum, Brad DeLong, and others have pointed out, the SSA estimates are very conservative, and quite moderate projections of economic growth push the exhaustion date into the indefinite future.

But the privatizers won’t take yes for an answer when it comes to the sustainability of Social Security. Their answer to the pretty good numbers is to say that the trust fund is meaningless, because it’s invested in U.S. government bonds. They aren’t really saying that government bonds are worthless; their point is that the whole notion of a separate budget for Social Security is a fiction. And if that’s true, the idea that one part of the government can have a positive trust fund while the government as a whole is in debt does become strange.

But there are two problems with their position.

The lesser problem is that if you say that there is no link between the payroll tax and future Social Security benefits - which is what denying the reality of the trust fund amounts to - then Greenspan and company pulled a fast one back in the 1980s: they sold a regressive tax switch, raising taxes on workers while cutting them on the wealthy, on false pretenses. More broadly, we’re breaking a major promise if we now, after 20 years of high payroll taxes to pay for Social Security’s future, declare that it was all a little joke on the public.

The bigger problem for those who want to see a crisis in Social Security’s future is this: if Social Security is just part of the federal budget, with no budget or trust fund of its own, then, well, it’s just part of the federal budget: there can’t be a Social Security crisis. All you can have is a general budget crisis. Rising Social Security benefit payments might be one reason for that crisis, but it’s hard to make the case that it will be central.

But those who insist that we face a Social Security crisis want to have it both ways. Having invoked the concept of a unified budget to reject the existence of a trust fund, they refuse to accept the implications of that unified budget going forward. Instead, having changed the rules to make the trust fund meaningless, they want to change the rules back around 15 years from now: today, when the payroll tax takes in more revenue than SS benefits, they say that’s meaningless, but when - in 2018 or later - benefits start to exceed the payroll tax, why, that’s a crisis. Huh?

I don’t know why this contradiction is so hard to understand, except to echo Upton Sinclair: it’s hard to get a man to understand something when his salary (or, in the current situation, his membership in the political club) depends on his not understanding it. But let me try this one more time, by asking the following: What happens in 2018 or whenever, when benefits payments exceed payroll tax revenues?

The answer, very clearly, is nothing.

The Social Security system won’t be in trouble: it will, in fact, still have a growing trust fund, because of the interest that the trust earns on its accumulated surplus. The only way Social Security gets in trouble is if Congress votes not to honor U.S. government bonds held by Social Security. That’s not going to happen. So legally, mechanically, 2018 has no meaning.

Now it’s true that rising benefit costs will be a drag on the federal budget. So will rising Medicare costs. So will the ongoing drain from tax cuts. So will whatever wars we get into. I can’t find a story under which Social Security payments, as opposed to other things, become a crucial budgetary problem in 2018.

What we really have is a looming crisis in the General Fund. Social Security, with its own dedicated tax, has been run responsibly; the rest of the government has not. So why are we talking about a Social Security crisis?

It’s interesting to ask what would have happened if the General Fund actually had been run responsibly - which is to say, if Social Security surpluses had been kept in a “lockbox”, and the General Fund had been balanced on average. In that case, the accumulating trust fund would have been a very real contribution to the government as a whole’s ability to pay future benefits.

As long as Social Security surpluses were being invested in government bonds, they would have reduced the government’s debt to the public, and hence its interest bill.

We would, it’s true, eventually have reached a point at which there was no more debt to buy, that is, a point at which the government’s debt to the public had been more or less paid off. At that point, it would have been necessary to invest the growing trust fund in private-sector assets. This would have raised some management issues: to protect the investments from political influence, the trust fund would have had to be placed in a broad index. But the point is that the trust fund would have continued to make a real contribution to the government’s ability to pay future benefits.

And if we are now much less optimistic about the government’s ability to honor future obligations than we were four years ago, when Alan Greenspan urged Congress to cut taxes to avoid excessive surpluses, it’s not because Social Security’s finances have deteriorated - they have actually improved (the projected exhaustion date of the trust fund has moved back 5 years since that testimony.) It’s because the General Fund has plunged into huge deficit, with Bush’s tax cuts the biggest single cause.

I’m not a Pollyanna; I think that we may well be facing a fiscal crisis. But it’s deeply misleading, and in fact an evasion of the real issues, to call it a Social Security crisis.

Rates of Return on Private Accounts

Privatizers believe that privatization can improve the government’s long-term finances without requiring any sacrifice by anyone - no new taxes, no net benefit cuts (guaranteed benefits will be cut, but people will make it up with the returns on their accounts.) How is this possible?

The answer is that they assume that stocks, which will make up part of those private accounts, will yield a much higher return than bonds, with minimal long-term risk.

Now it’s true that in the past stocks have yielded a very good return, around 7 percent in real terms - more than enough to compensate for additional risk. But a weird thing has happened in the debate: proposals by erstwhile serious economists such as Martin Feldstein appear to be based on the assertion that it’s a sort of economic law that stocks will always yield a much higher rate of return than bonds. They seem to treat that 7 percent rate of return as if it were a natural constant, like the speed of light.

What ordinary economics tells us is just the opposite: if there is a natural law here, it’s that easy returns get competed away, and there’s no such thing as a free lunch. If, as Jeremy Siegel tells us, stocks have yielded a high rate of return with relatively little risk for long-run investors, that doesn’t tell us that they will always do so in the future. It tells us that in the past stocks were underpriced. And we can expect the market to correct that.

In fact, a major correction has already taken place. Historically, the price-earnings ratio averaged about 14. Now, it’s about 20. Siegel tells us that the real rate of return tends to be equal to the inverse of the price-earnings ratio, which makes a lot of sense.[1] More generally, if people are paying more for an asset, the rate of return is lower. So now that a typical price- earnings ratio is 20, a good estimate of the real rate of return on stocks in the future is 5 percent, not 7 percent.

Here’s another way to arrive at the same result. Suppose that dividends are 3 percent of stock prices, and that the economy grows at 3 percent (enough, by the way, to make the trust fund more or less perpetual.) Not all of that 3 percent growth accrues to existing firms; the Dow of today is a very different set of firms than the Dow of 50 years ago. So at best, 3 percent economic growth is 2 percent growth for the set of existing firms; add to dividend yield, and we’ve got 5 percent again.

That’s still not bad, you may say. But now let’s do the arithmetic of private accounts.

These accounts won’t be 100 percent in stocks; more like 60 percent. With a 2 percent real rate on bonds, we’re down to 3.8 percent.

Then there are management fees. In Britain, they’re about 1.1 percent. So now we’re down to 2.7 percent on personal accounts - barely above the implicit return on Social Security right now, but with lots of added risk. Except for Wall Street firms collecting fees, this is a formula to make everyone worse off. Privatizers say that they’ll keep fees very low by restricting choice to a few index funds. Two points.

First, I don’t believe it. In the December 21 New York Times story on the subject, there was a crucial giveaway: “At first, individuals would be offered a limited range of investment vehicles, mostly low-cost indexed funds. After a time, account holders would be given the option to upgrade to actively managed funds, which would invest in a more diverse range of assets with higher risk and potentially larger fees.” (My emphasis.)

At first? Hmm. So the low-fee thing wouldn’t be a permanent commitment. Within months, not years, the agitation to allow “choice” would begin. And the British experience shows that this would quickly lead to substantial dissipation on management fees.

Second point: if you’re requiring that private accounts be invested in index funds chosen by government officials, what’s the point of calling them private accounts? We’re back where we were above, with the trust fund investing in the market via an index.

Now I know that the privatizers have one more trick up their sleeve: they claim that because these are called private accounts, the mass of account holders will rise up and cry foul if the government tries to politicize investments. Just like large numbers of small stockholders police governance problems at corporations, right? (That’s a joke, by the way.)

If we are going to invest Social Security funds in stocks, keeping those investments as part of a government-run trust fund protects against a much clearer political economy danger than politicization of investments: the risk that Wall Street lobbyists will turn this into a giant fee-generating scheme.

To sum up: claims that stocks will always yield high, low-risk returns are just bad economics. And tens of millions of small private accounts are a bad way to take advantage of whatever the stock market does have to offer. There is no free lunch, and certainly not from private accounts.

The Distant Future

The distant future plays a strangely large role in the current discussion. To convince us of the direness of our plight, privatizers invoke the vast combined infinite-horizon unfunded liabilities of Social Security and Medicare. Their answer to that supposed danger is to borrow trillions of dollars to pay for private accounts, which supposedly will solve the problem through the magic of high stock returns (a supposition I’ve just debunked.) And all that borrowing will be harmless, say the privatizers, because the long-run budget position of the federal government won’t be affected: payments 30, 40, 50 years from now will be reduced, and in present value terms that will offset the borrowing over the nearer term.

I’m all for looking ahead. But most of this is just wrong-headed, on multiple levels.

Let me start with the easiest piece: why the distant future of Medicare is something we really should ignore. And bear in mind that most of those huge numbers you hear about implicit liabilities come from Medicare, not Social Security; more to the point, they mostly come from projected increases in medical costs, not demography.

Now the main reason medical costs keep rising is that the range of things medicine can do keeps increasing. In the last few years my father and mother-inlaw have both had life-saving and life-enhancing medical procedures that didn’t exist a decade or two ago; it’s procedures like those that account for the rising cost of Medicare.

Long-run projections assume, perhaps correctly, that this trend will continue. In 2100 Medicare may be paying for rejuvenation techniques or prosthetic brain replacements, and that will cost a lot of money.

But does it make any sense to worry now about how to pay for all that? Intergenerational responsibility is a fine thing, but I can’t see why the cost of medical treatments that have not yet been invented, applied to people who have not yet been born, should play any role in shaping today’s policy.

Social Security’s distant future isn’t quite as speculative, but it’s still pretty uncertain. What do you think the world will look like in 2105? My guess is that by then the computers will be smarter than we are, and we can let them deal with things; but the truth is that we haven’t the faintest idea. I doubt that anyone really believes that it’s important to look beyond the traditional 75-year window. It has only become fashionable lately because it’s a way to make the situation look more dire.

Now let’s return slightly more to the world outside science fiction, and ask the question: can we really count purported savings several decades out as an offset to huge borrowing today?

The answer should be a clear no, for one simple reason: a bond issue is a true commitment to repay, while a purported change in future benefits is just a suggestion to whoever is running the country decades from now.

If the Bush plan cuts guaranteed benefits 30 years out, what does that mean?

Maybe benefits will actually be cut on schedule, but then again maybe they won’t - remember, the over-65 voting bloc will be even bigger then than it is now. Or maybe, under budgetary pressure, benefits would have been cut regardless of what Bush does now, in which case his plan doesn’t really save money in the out years.

Financial markets, we can be sure, will pay very little attention to projections about how today’s policies will affect the budget 30 years ahead. In fact, we’ve just had a demonstration of how little attention they will pay: the prescription drug plan.

As has been widely noted, last year’s prescription drug law, if it really goes into effect as promised, worsens the long-run federal budget by much more than the entire accounting deficit of Social Security. If markets really looked far ahead, the passage of that law should have caused a sharp rise in interest rates, maybe even a crisis of confidence in federal solvency. In fact, everyone pretty much ignored the thing - just as they’ll ignore the putative future savings in the Bush plan. What markets will pay attention to, just as they did in Argentina, is the surge in good old-fashioned debt.

Privatization Is a Solution in Search of a Problem

As I’ve described it, the case for privatization is a mix of strange and inconsistent budget doctrines, bad economics, dubious political economy, and science fiction.

What’s wrong with these people?

The answer is definitely not that they are stupid. In fact, the case made by the privatizers is fiendishly ingenious in its Jesuitical logic, its persuasiveness to the unprepared mind.

But many of the people supporting privatization have to know better. Why, then, don’t they say so? Because Social Security privatization is a solution in search of a problem. The right has always disliked Social Security; it has always been looking for some reason to dismantle it. Now, with a window of opportunity created by the public’s rally-around-the-flag response after 9/11, the Republican leadership is making a full-court press for privatization, using any arguments at hand.

There are both crude and subtle reasons why economists who know better don’t take a stand against the illogic of many of the privatizers’ positions. The crude reason is that a conservative economist who doesn’t support every twist and turn of the push for privatization faces political exile. Any hint of intellectual unease would, for example, kill the chances of anyone hoping to be appointed as Greenspan’s successor. The subtle reason is that many economists hold the defensible position that a pay-as-you-go system is bad for savings and long-run growth. And they hope that a bad privatization plan may nonetheless be the start of a reform that eventually creates a better system.

But those hopes are surely misplaced. So far, everyone - and I mean everyone - who has signed on to Bush administration plans in the hope that they can be converted into something better has ended up used, abused, and discarded. It happened to John DiIulio, it happened to Colin Powell, it happened to Greg Mankiw, and it’s a safe prediction that those who think they can turn the Bush drive to dismantle Social Security into something good will suffer the same fate.

———————————————–

Paul Krugman won the John Bates Clark medal in 1991 - awarded every second year to a single economist - for his work on imperfect competition and international trade. He is now a Professor of Economics and International Affairs at Princeton University, and a regular op-ed columnist for the New York Times.

Footnotes

[1] For those who want to know: suppose that the economy is in steady-state growth, with both the rental rate on capital and Tobin’s q constant. Then the rate of return on stocks is equal to the earnings-price ratio. Obviously that’s an oversimplification, but it looks pretty good as a rule of thumb.

(In accordance with Title 17 U.S.C. Section 107, this material is distributed without profit to those who have expressed a prior interest in receiving the included information for research and educational purposes.)

Social Security and Me
By Kevin Drum
Washington Monthly
December 17th, 2004

Matt Yglesias makes an important point about Social Security framing today:

I’m not sure the older liberals who run the show quite understand how overwhelmingly important it is to keep the “there is no crisis” message front and center in the Social Security debate. Most of the young people I know — including myself until very recently — have been taken in by a decades-long effort on behalf of privatizers into believing that Social Security is in “crisis,” and that if we do nothing the system will “go bankrupt” before we retire, meaning that the system will somehow collapse and we won’t get any benefits.

This is true, and I used to be one of these people too. As a well-informed citizen, I knew that Social Security was unsustainable, that life expectancies were increasing, that fewer workers would be supporting more retirees in the future, and in general, that the program was facing a demographic timebomb that would cause it to go bankrupt within a couple of decades.

This was back in the mid-90s, and for some reason I took an interest in finding out more. So I wrote off for a copy of the trustees report, read up on tax policy and demographic projections, pored through various analyses, and , to my surprise , learned that the problem was either (a) fairly modest and quite solvable or (b) not a problem at all.

Social Security is going to get more expensive over time, but it’s not going to keep getting more expensive forever. Starting in about a decade costs will go up, but then, after about 20 years, they’ll flatten out. And the size of the increase, from about 4% of GDP to 6% of GDP, just isn’t a crisis. What’s more, when you start to study the trustees’ projections, you realize that even their “intermediate” projection is pretty conservative. It’s quite possible that if we leave the system completely alone it will be fine. And even if it’s not, there’s plenty of time to make the small tweaks necessary to keep it properly funded.

In other words, after actually studying the issue, I changed my opinion almost 180 degrees. Nothing is going bankrupt, benefits will continue to be paid forever, and future funding problems are both modest in size and not that hard to deal with.

Unfortunately, Bill Clinton, Al Gore, and now George Bush, each for their own reasons, have found it politically convenient to use Social Security as a useful bogeyman for scaring the public. The difference is that, unlike me back in 1995, they all know better. It’s too bad they couldn’t have figured out some real problems to focus on instead.

(In accordance with Title 17 U.S.C. Section 107, this material is distributed without profit to those who have expressed a prior interest in receiving the included information for research and educational purposes.)

One Man’s Retirement Math: Social Security Wins
By David R. Francis
The Christian Science Monitor

December 27th, 2004

Click here to read this story online:
http://www.csmoni tor.com/2004/1227/p01s03-cogn.html

At the heart of President Bush’s plan to sell Social Security private accounts is a simple notion: You’re always better off investing your retirement money than letting the government do it.
By doing it yourself, you can stow some money in the stock market, and over the long run will get a better return on that investment than today’s Social Security system offers.

The idea is broadly accepted. That’s why the administration’s plan to partially privatize the system sounds appealing to many. But that better return won’t always happen.

Just ask Stanley Logue of San Diego.

For 45 years, the defense-industry analyst paid into the system until his retirement in 1994. But with all the recent hoopla over reform, Mr. Logue, a Massachusetts Institute of Technology graduate, decided to go back and check his own records. Would he have done better investing his money than the bureaucrats at the Social Security Administration?

He recorded all the payroll taxes he paid into the system (including the matching amount from his employer), tracked down the return the Social Security Trust Fund earned for each of the 45 years, and then compared the result with what he would have gotten had he been able to invest the same amount of payroll tax money over the same period in the Dow Jones Industrial Average (including dividends).

To his surprise, the Social Security investment won out: $261,372 versus $255,499, a difference of $5,873.

It’s an astonishing finding. The DJIA represents blue-chip stocks. Social Security invests in US Treasury bonds. Over long periods of time, stocks have consistently outperformed bonds. So, you would think that Logue’s theoretical stock investments from 1950 to 1994 would have surely outpaced the return on government bonds.

The fact that they didn’t illustrates one of the hard truths about stock investing: Timing matters.

Although Logue started pouring money into Social Security in the 1950s and early 1960s, some of the best years for stocks, he hadn’t accumulated a lot of money.

So the gains of his theoretical stock portfolio would have been limited.

By the time he had substantial sums, the market swooned for long periods. From 1965 to 1982, for instance, the DJIA made no progress. Logue retired before the real run-up in stocks in the latter half of the late 1990s.

So the real lesson from his analysis is that any pension plan based on stock investments carries extra risks.

Advocates of privatization point out - correctly - that Logue’s analysis compares theoretical stock returns with what the Social Security Trust Fund earned - not what he himself would get from the system.

From that perspective, the investment approach looks better, they argue. Over the long run, a typical worker can expect to earn 4.6 percent a year (after administrative costs) on a diversified portfolio of stocks and bonds and only about 2 percent or less from Social Security, according to federal estimates reported by Michael Tanner of the Cato Institute, long a proponent of privatization. Hypothetically, someone earning $30,000 annually would at the end of a 40-year career receive nearly twice as much under the investment approach ($344,000) than with Social Security ($185,000).

Who’s right: Logue or Mr. Tanner?

The debate hinges considerably on what people want their retirement system to be. Social Security has always been an insurance program. It was never intended as an investment scheme. So everyone - retirees, the disabled, widows, and orphans - receive guaranteed monthly income. The “return” on their Social Security contributions depends largely on how long they live. Those in their 90s have enjoyed superb returns. Those who don’t live as long benefit less.

Private accounts, by contrast, involve far more variability, both sides agree. Individuals who enter and exit the market at the right times would undoubtedly do better under privatization.

But under Britain’s privatized pension system, so many retirees are doing so poorly at this moment that a commission warned this fall that widespread poverty among the elderly may be returning, which could require massive new government spending.

Presumably, President Bush’s plan would offer the choice to meld insurance and private investment: much less guaranteed income in return for the opportunity - and risk - of earning more in the markets.

“Because financial asset returns are volatile, benefits under a personal account system would fluctuate,” notes Bill Dudley, an economist at Goldman, Sachs & Co., a New York investment bank. “On a risk-adjusted basis, the privatized account … becomes much less compelling.”

There are other problems with private accounts. Administration expenses of the present Social Security system are minuscule compared with the size of the benefits provided. The Bush administration so far has provided no details on its private accounts plan. But if these are handled by Wall Street, the fees could be sizable, dissipating some of the return from investing in stocks. Logue takes no account of such expenses in his analysis.

Further, administrative costs and difficulties for private business could be large as companies, big and small, try to deduct the right amount from a payroll and put it into a private account in a timely fashion.

A study by the Congressional Research Service (CRS) notes some complexities: 650,000 employers go out of business or start new businesses each year. More than 4 million employers have 10 or fewer employees, often having record-keeping problems and errors. About 12 million to 15 million individuals are self-employed and presumably would have to send money directly to a private account.

So the complexities of change are substantial. If the extra return from privatization is not very advantageous, “why even consider changes that all agree would be very disruptive?” asks Logue.

(c) Copyright 2004 The Christian Science Monitor. All rights reserved.

(In accordance with Title 17 U.S.C. Section 107, this material is distributed without profit to those who have expressed a prior interest in receiving the included information for research and educational purposes.)

Inventing a Crisis
By Paul Krugman
The New York Times

December 7th, 2004

Privatizing Social Security - replacing the current system, in whole or in part, with personal investment accounts - won’t do anything to strengthen the system’s finances. If anything, it will make things worse. Nonetheless, the politics of privatization depend crucially on convincing the public that the system is in imminent danger of collapse, that we must destroy Social Security in order to save it.
I’ll have a lot to say about all this when I return to my regular schedule in January. But right now it seems important to take a break from my break, and debunk the hype about a Social Security crisis.

There’s nothing strange or mysterious about how Social Security works: it’s just a government program supported by a dedicated tax on payroll earnings, just as highway maintenance is supported by a dedicated tax on gasoline.

Right now the revenues from the payroll tax exceed the amount paid out in benefits. This is deliberate, the result of a payroll tax increase - recommended by none other than Alan Greenspan - two decades ago. His justification at the time for raising a tax that falls mainly on lower- and middle-income families, even though Ronald Reagan had just cut the taxes that fall mainly on the very well-off, was that the extra revenue was needed to build up a trust fund. This could be drawn on to pay benefits once the baby boomers began to retire.

The grain of truth in claims of a Social Security crisis is that this tax increase wasn’t quite big enough. Projections in a recent report by the Congressional Budget Office (which are probably more realistic than the very cautious projections of the Social Security Administration) say that the trust fund will run out in 2052. The system won’t become “bankrupt” at that point; even after the trust fund is gone, Social Security revenues will cover 81 percent of the promised benefits. Still, there is a long-run financing problem.

But it’s a problem of modest size. The report finds that extending the life of the trust fund into the 22nd century, with no change in benefits, would require additional revenues equal to only 0.54 percent of G.D.P. That’s less than 3 percent of federal spending - less than we’re currently spending in Iraq. And it’s only about one-quarter of the revenue lost each year because of President Bush’s tax cuts - roughly equal to the fraction of those cuts that goes to people with incomes over $500,000 a year.

Given these numbers, it’s not at all hard to come up with fiscal packages that would secure the retirement program, with no major changes, for generations to come.

It’s true that the federal government as a whole faces a very large financial shortfall. That shortfall, however, has much more to do with tax cuts - cuts that Mr. Bush nonetheless insists on making permanent - than it does with Social Security.

But since the politics of privatization depend on convincing the public that there is a Social Security crisis, the privatizers have done their best to invent one.

My favorite example of their three-card-monte logic goes like this: first, they insist that the Social Security system’s current surplus and the trust fund it has been accumulating with that surplus are meaningless. Social Security, they say, isn’t really an independent entity - it’s just part of the federal government.

If the trust fund is meaningless, by the way, that Greenspan-sponsored tax increase in the 1980’s was nothing but an exercise in class warfare: taxes on working-class Americans went up, taxes on the affluent went down, and the workers have nothing to show for their sacrifice.

But never mind: the same people who claim that Social Security isn’t an independent entity when it runs surpluses also insist that late next decade, when the benefit payments start to exceed the payroll tax receipts, this will represent a crisis - you see, Social Security has its own dedicated financing, and therefore must stand on its own.

There’s no honest way anyone can hold both these positions, but very little about the privatizers’ position is honest. They come to bury Social Security, not to save it. They aren’t sincerely concerned about the possibility that the system will someday fail; they’re disturbed by the system’s historic success.

For Social Security is a government program that works, a demonstration that a modest amount of taxing and spending can make people’s lives better and more secure. And that’s why the right wants to destroy it.

(In accordance with Title 17 U.S.C. Section 107, this material is distributed without profit to those who have expressed a prior interest in receiving the included information for research and educational purposes.)

System Needs Tweak, Not Disaster Relief
By Michael Hiltzik
The Los Angeles Times

November 29th, 2004

One mark of a truly terrible idea is that it outlasts the delusions that first gave it life. In today’s world, there’s no better example than the push for Social Security “privatization,” a threadbare artifact of the last stock market boom.

The diversion of a portion of Social Security taxes into some form of individual investment account has been promoted for years as a solution to the system’s impending collapse. President Bush has draped the old notion in “ownership society” rhetoric, part of his anti-tax credo that individuals are wiser at spending their money than the government and thus should keep more of it.

As appealing as this may sound, when applied to Social Security it’s not a device to rescue the system from ruin. Instead, it’s a weapon aimed at the system’s heart.

The privatization idea was born back when the stock market seemed to be making everybody rich. Economist Martin Feldstein, the patriarch of privatization, salted his manifestos with calculations of yields and rates of return for private investments versus those imputed in Social Security taxes and benefits. The latter always came up dismally short.

One flaw in this methodology should be obvious: The good times didn’t last. Although the stock market more than tripled in value from 1995 through 1999 (as measured by the Standard & Poor’s 500 index), it fell 50% from then to the end of 2003. Investors who stood pat from 1995 through 2003 would have seen two-thirds of their initial gains go up in smoke.

That’s the risk facing individuals who invest their accounts prudently in broad stock funds. What of those who opt to take a flier on stocks like Krispy Kreme (down 80% since its peak) and fray their safety net beyond repair?

In any case, judging Social Security like an investment fund defines it as something it was never meant to be. Social Security is a social insurance program whose benefits were never expected to have a direct relationship to contributions. After all, the very first Social Security recipient, Ida May Fuller, paid a mere $24.75 into the program, but collected $22,888.92 between 1940 and her death in 1975.

Reflecting its underlying purpose, Social Security has features that private investment accounts can’t match: Its payments are inflation-indexed, they can’t run out during the recipient’s lifetime, they’re shielded from market fluctuations and they’re payable to survivors for their lifetimes. The system is progressive, meaning it covers a larger share of the needs of low-income members than of the wealthy. Private investment accounts would almost certainly do the opposite, laying the most risk onto the two-thirds of all elderly retirees for whom Social Security is the sole or principal source of income.

But what about the system’s health? Fear-mongering about the condition of Social Security is the handmaiden of the privatization lobby. The words “insolvency,” “bankruptcy” and “disaster” are casually tossed around in the hope that a numbed public will become convinced that, barring a draconian solution, no one’s Social Security benefits will be safe.

In fact, this description isn’t remotely accurate. Social Security taxes, interest earned from the system trust fund’s holdings of Treasury securities (currently $1.7 trillion and scheduled to grow to nearly $4 trillion by 2022) and revenue from the redemption of those securities are projected to be enough to fund 100% of all scheduled benefits through 2042. At that point the trust fund will be exhausted, and tax revenue will be sufficient to fund only about 73% of currently scheduled benefits.

These figures suggest that the system needs tweaking, not disaster relief. They certainly don’t warrant performing radical surgery in an atmosphere of apocalyptic panic four decades in advance of the crisis point.

Serious economists proposing to strengthen the system say its projected deficit can be eliminated through any number of modest changes. These include raising the maximum annual income on which Social Security tax is levied (currently $87,900), bringing new state and local government employees into the system to broaden its base, and maintaining the federal estate tax and allocating the proceeds to benefits.

So where does the impetus for privatization come from? The campaigners include anti-tax ideologues and groups affiliated with the brokerage and insurance industries, which hope to cash in on the creation of millions of individual rainy-day accounts. Mutual fund executives have recently warned that they can’t accommodate a surge of small accounts without charging hefty fees, which doesn’t mean they don’t want the business, just that they don’t want limits on their fees. In other words, the retirement-bound individual is being set up for a shearing.

President Bush’s “ownership society” ideology, which glorifies personal responsibility and demonizes government programs, sounds great - until you remember that Americans once lived in such a free-market paradise. It was the 1920s, and it ended in an economic catastrophe that led to the very Social Security system that Bush is now plotting to destroy.

In the months to come the privatization gang will muster reams of scary-sounding facts and figures, produced through obscure recipes like “generational accounting,” to convince people that Social Security is on the verge of imploding.

Their solution would erode the most effective social welfare program the U.S. has ever enacted and cede a significant portion of the national retirement nest egg to Wall Street, all in the name of an unnecessary “reform.” The really pressing issue for Social Security is not how to shore up the system’s finances, but how to protect it from reformers like these.

(In accordance with Title 17 U.S.C. Section 107, this material is distributed without profit to those who have expressed a prior interest in receiving the included information for research and educational purposes.)

The Budget Mess Bush Can No Longer Ignore
By Robert Kuttner
November 22nd, 2004

Business Week

The U.S. economy can’t grow its way out of such big deficits

Whatever happened to the deficit hawks? As the celebration ends, Republicans should begin to take a hard look at the budget mess and the broader economic calamity that could befall President George W. Bush in his second term. Most of it is of his own making. And with wall-to-wall control of the government since 2002 and four full years since the last Democratic Administration, the responsibility will be entirely his.
Bush now has the votes to make his tax cuts permanent and to add new ones. The Congressional Budget Office (CBO), which reports to Republican committee chairmen, admits that with realistic assumptions the deficit will total more than $4.4 trillion by 2014 and not the $2.2 trillion in official projections. That’s because making the 2001 and 2003 tax cuts permanent will cost an additional $1.65 trillion over 10 years. Preventing the alternative minimum tax from biting the middle class will cost $603 billion more. Tax simplification could be a net revenue loser, too.

AND IF BUSH SUCCEEDS in partly privatizing Social Security, an additional $2 trillion will be added to the national debt. Bush will need to borrow money — or raise taxes — both to finance new private retirement accounts and to keep payments flowing to current retirees as he has promised. There is no way for the economy to grow out of deficits of this scale, and at some point they will trigger higher interest rates, slowing growth. The currency markets are already nervous. The dollar fell to a low against the euro on Friday, because foreign investors are looking at the budget and current-account deficits and wondering who is going to finance them.

Administration and CBO projections also assume, optimistically, that federal spending growth will not exceed the rate of inflation. But in Bush’s first term, spending growth ran almost double the inflation rate despite cuts in domestic social programs. Although the President is committed in principle to shrinking government, he increased spending for signature initiatives such as No Child Left Behind and prescription-drug subsidies, to the frustration of many conservatives. He also tolerated huge pork barrel outlays. The Iraq war will continue to boost spending. So far most Bush cuts affect mainly the poor, not his constituents. But if he wants to offset tax reductions with additional program cuts, he will have to start curbing big middle-class programs such as Medicare — and voters will notice.

Given low domestic savings rates, budget deficits of this magnitude require foreign financing. For years economists have been warning that the “co-dependency” between the U.S. and Asian central banks — in which the immense American budget and trade deficits are financed mainly by Japan and China as long as we keep importing their products — cannot be sustained indefinitely. Bush’s budget deficits have pushed this arrangement close to a tipping point and a dollar crash. The trade deficit is in excess of 5% of gross domestic product and heading toward 7%. At some degree of U.S. foreign indebtedness, the world will start dumping the dollar and shorting it in the currency markets.

The trade deficits would be smaller if China and Japan ran more open economies. But Bush’s heavy dependence on the central banks of these countries undercuts any leverage Washington has to induce them to open further to U.S. exports and to run more transparent economies. In addition, a weakening dollar scares off non-central bank private foreign investors in American securities. There has been very little private foreign investment in U.S. equities and government bonds lately.

Adding to the trade deficit is the high cost of oil. Despite the recent decline to below $50 a barrel, Philip K. Verleger of the Institute for International Economics projects that crude prices will reach $60 to $70 within two years. The Administration’s energy policy mainly consists of weakened pollution standards and more domestic drilling.

Twelve years ago the business-backed Concord Coalition made a huge difference in fiscal policy. Its campaign for budget balance spotlighted the irresponsibility of the accumulated deficits of Ronald Reagan and George H.W. Bush and added pressure on the new Clinton Administration to get serious about deficit reduction, even at the cost of raising taxes. One hasn’t heard much from the coalition lately and even less from business Republicans.

Robert Kuttner is co-editor of The American Prospect and author of Everything for Sale.

(In accordance with Title 17 U.S.C. Section 107, this material is distributed without profit to those who have expressed a prior interest in receiving the included information for research and educational purposes.)